Fair Value: RM0.26. Inspection, Test & Measurement Equipment Player. Not Rated. ACE Market Listing N E W L I S T I N G. Company Background

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1 N E W L I S T I N G Tuesday, February 20, 2018 FBMKLCI: 1, Sector: Technology THIS REPORT IS STRICTLY FOR INTERNAL CIRCULATION ONLY* QES Group Berhad Inspection, Test & Measurement Equipment Player Fair Value: RM0.26 ACE Market Listing Not Rated Wilson Loo, CFA Tel: wilsonloo@ta.com.my Company Background QES Group is principally involved in the distribution of inspection, test and measurement equipment to the electrical and electronics and automotive industry as well as materials and engineering solutions to the semiconductor industry. Apart from distribution, the group is also involved in the manufacturing of optical inspection and automated handling equipment as well as advanced wafer measurement system. Share Information Listing ACE Market Enlarged Share Capital (mn) Market RM0.19 (RM mn) Issue price (RM) 0.19 Oversubscription rate - Estimated free float (%) 30.0 IPO Structure The IPO is expected to raise gross proceeds of RM28.8mn and entails the public issue of 151,661,000 new shares and offer for sale of 75,831,000 existing shares, respectively accounting for 20.0% and 10.0% of the group s enlarged share capital. Tentative Listing Dates Closing of application period Balloting of Applicants Allotments of shares Listing 23-Feb Feb-18 5-Mar-18 8-Mar-18 Investment Thesis 1. Positioned in A Growing Industry 2. Established Distributor for Reputable Brands of Equipment 3. Expansion of Manufacturing Division 4. Expansion of Distribution Division Key Risks 1. Foreign Exchange Fluctuations 2. Technological Advancements Valuation At the IPO price of RM0.19/share, the QES is priced at a trailing PE of 9.1x. We value QES at a fair value of RM0.26/share based on a target PE of 12.0x and CY18 EPS of 2.2sen/share. As a benchmark, peers in the test and measurement market such as Elsoft Research Bhd and ViTrox Corporation Bhd respectively are trading at PE multiples of 19.6x and 29.0x. The discount we assign to QES is in consideration of it being a small-cap listing on the ACE Market and its relatively lower margins (single-digit versus peers double-digit) due to the bulk of its revenue derived from distribution which fetch thinner margins. Not Rated. Ratio & Analysis NAV per share (post IPO) (sen) 11.7 Price to NAV(x) 1.6 Proforma Gearing (x) 0.2 Utilisation of Proceeds % Capital expenditure 37.2 Repayment of bank borrowings 24.3 Development of 3 key products 16.8 General working capital 11.3 Estimated listing expenses 10.4 Earnings Summary FYE Dec (RMmn) FY15 FY16 FY17F FY18F FY19F Revenue EBITDA EBITDA margin (%) Depreciation & amortisation (1.8) (1.7) (1.7) (2.5) (3.6) EBIT Net finance costs (1.4) (1.0) (0.8) (0.2) 0.3 PBT Taxes (2.3) (1.9) (3.8) (4.1) (4.3) MI (0.4) (0.7) (0.9) (1.0) (1.0) PAT (-MI) EPS (sen) EPS Growth (%) PE (x) DPS (sen) Dividend yield (%) Page 1 of 11

2 Company Background QES Group (QES) is principally involved in the distribution of inspection, test and measurement equipment to the electrical and electronics and automotive industry as well as materials and engineering solutions to the semiconductor industry. Apart from distribution, the group is also involved in the manufacturing of optical inspection and automated handling equipment as well as advanced wafer measurement system. Figure 1: Business Activities Since its establishment in 1991, QES has sold more than 8,000 units of equipment and served over 2,400 customers, the majority of which are multinational corporations within the electrical and electronics, automotive and semiconductor industries across the ASEAN region. The group s regional presence is facilitated by its direct distribution network via subsidiaries in Malaysia, Indonesia, Hong Kong, the Philippines, Singapore, Thailand and Vietnam as well as indirect distribution network via dealers and distributors in France, Germany, Singapore and Taiwan. By country, Malaysia is the group s principal market, contributing on average 46.3% to revenue during FY14 to FY16 and this is followed by its top three foreign markets: Vietnam (12.1%), Singapore (11.9%) and the Philippines (11.3%). Figure 2: Customers Page 2 of 11

3 The group started out with the distribution of inspection, test and measurement equipment to the electrical and electronics and automotive industry and today it is the main revenue contributor (on average at 66.5% during FY14 to FY16). Equipment are sourced from abroad and includes reputable brands such as Hitachi High-Tech Science Corporation, SPECTRO Analytical Instruments GmbH, Nikon Corporation and Rigaku Corporation. Complementing this, installation, upgrading and after-sales services are also provided. After-sales services such as scheduled maintenance and servicing of equipment offers an avenue for recurring income. Later on in 1997, the group ventured into the distribution of materials and engineering solutions to the semiconductor industry. The materials distributed are wide ranging and among others include conditioning discs, back grinding wheels, quartz parts, back grinding tape and dicing tape. As for engineering solutions, QES specialises in industrial and environmental facilities sub-systems. This includes gas abatement systems which are used to process and treat harmful gaseous emissions from semiconductor manufacturing, chillers, gas cabinets and heat exchangers. The group diversified into manufacturing in 1998 with a focus on optical inspection and automated handling equipment for the semiconductor industry which are used during the course of wafer fabrication (i.e. back grinding, labelling, packaging, post dicing, post wafer probing, sorting and transfer). The group s factory is situated at the same location as its head office in Glenmarie Industrial Park, Shah Alam and the equipment are developed by QES s engineers and in collaboration with vendors where required. Going forward, the division is poised for further growth with development plans for 3 key products in place. Key Management & Substantial Shareholders The group is led by Chew Ne Weng and Liew Soo Keang. They both are the group s promoters and post-ipo would remain in control with a collective stake of 70.0%, respectively with 41.1% and 28.9%. Table 1: Substantial Shareholders Name Before IPO (%) After IPO (%) Direct Indirect Direct Indirect Chew Ne Weng Liew Soo Keang Total Chew Ne Weng is the co-founder and Managing Director/President of the group. He graduated from the National University of Singapore in 1987 with a Bachelor of Mechanical Engineering and possesses 30 years of experience in the engineering industry. In the early days of this career, he was attached with Cairnhill Precision Private Limited, Singapore, involved in the installation, troubleshooting and after sales service of metrology equipment. In his current role, he is responsible for QES s overall strategic direction and management. Liew Soo Keang, as Executive Director is responsible for overseeing the group s distribution arm. He graduated from University Malaya in 1987 with a Bachelor Degree (Hons) (First Class) in Electrical Engineering and possesses 30 years of experience in the engineering industry. Prior to joining the group in 1997, he was attached to Intel Technology Sdn Bhd where responsibilities included semiconductor test equipment maintenance and services and overseeing test operations of Pentium microprocessors. Page 3 of 11

4 Table 2: Key Management Name Chew Ne Weng Liew Soo Keang Lee Hock Chin Lim Chee Keong Chin Guat Eem Yeoh Cheong Yeow Position Managing Director/President Executive Director Vice-President of Distribution Vice-President of Manufacturing General Manager of Human Resource and Administration General Manager of Finance IPO Structure QES s IPO entails the public issue of 151,661,000 new shares and offer for sale of 75,831,000 existing shares, collectively accounting for 30.0% of the group s enlarged share capital. At the issue price of RM0.19/share, the IPO implies a market capitalisation of RM144.1mn. The allocation of shares is as detailed in Table 3. Table 3: Allocation of Shares Public Issue to: No. of Shares % of Enlarged Market Value Share Capital Malaysian Public 37,915, % RM7.2mn Eligible Directors & Employees 9,265, % RM1.8mn Private Placement 104,480, % RM19.9mn Total 151,661, % RM28.8mn Offer for Sale to: No. of Shares % of Enlarged Market Value Share Capital Bumiputera Investors 75,831, % RM14.4mn Total 75,831, % RM14.4mn Of the expected total IPO proceeds of RM28.8mn, the bulk will be utilised for capital expenditure (37.2%), followed by repayment of bank borrowings (24.3%), product development (16.8%) and working capital (11.3%). Table 4: Utilisation of Proceeds Amount % of Gross Timeframe Proceeds Capital expenditure RM10.7mn 37.2 Within 24 months Repayment of bank borrowings RM7.0mn 24.3 Within 3 months Development of 3 key products RM4.9mn 16.8 Within 24 months General working capital requirements RM3.3mn 11.3 Within 24 months Estimated listing expenses RM3.0mn 10.4 Within 1 month RM28.8mn Investment Thesis Positioned in A Growing Industry On a broad level, QES is positioned in a growing industry with Malaysia s test and measurement market forecasted to grow at a CAGR of 6.9% from 2017 to 2021 on the back of global economic growth and expected growth of key end-user markets. For the electrical and electronics industry, the impetus for further growth stems from the proliferation of the Internet of things and big data analytics resulting in more complicated finished products which in turn requires more sophisticated test and measurement equipment. As for the automotive segment, upside to demand for test and measurement equipment is present from the increasing emphasis that is being placed on innovation and safety. Meanwhile, for the semiconductor industry where the test and measurement process is pivotal to ensure product quality, growth in demand for equipment is expected to be spurred Page 4 of 11

5 by the rising semiconductor content in devices and increasing sophistication of semiconductor components. For 2018, World Semiconductor Trade Statistics forecasts global semiconductor sales to grow by 7.0% YoY (vs. 21.6% in 2017). Established Distributor for Reputable Brands of Equipment With a long-standing presence of ~26 years in the industry, QES has established itself as a distributor for reputable brands of equipment. Among others, this includes brands such as Hitachi High-Tech Science Corporation and SPECTRO Analytical Instruments GmbH which the group have carried for over a decade. This, coupled with the group s efficient and reliable after-sales service have positioned QES among the preferred distributor of inspection, test and measurement equipment in the market. In 2016, the group was estimated to command a 9.2% market share in terms of revenue of Malaysia s test and measurement market. Expansion of Manufacturing Division The group is working on expanding its manufacturing division via the development of 3 key products for the semiconductor industry Fully Automated Vision Inspection System, Automatic Wafer Packing System and Automatic Wafer ID. This follows customer feedback and advancements in wafer and chip packaging technology towards hands-free and increasing levels of automation which satisfies requirement for lower cost of production and higher yields. RM4.9mn (16.8%) of the group s IPO proceeds have been earmarked for the development of these products. They are expected to be ready for commercial sales within 12 to 24 months after listing and correspondingly be the impetus for the manufacturing division. During FY14 to FY16 the division contributed on average 8.5% to revenue. Table 5: 3 Key Products Product Fully Automated Vision Inspection System (FAVIS) Automated Wafer Packing System (AWPS) Automatic Wafer ID (AWID) Description Upgraded vision inspection system with full automation covering the wafer probing, dicing and wire bonding processes. Fully automated wafer packing and unpacking system with robotic arm wafer handling. Upgraded wafer ID system with features such as fully automatic batch wafer ID reader and ID server to meet the semiconductor industry s stringent requirement. Expansion of Distribution Division QES sees further room for growth from the distribution division, its main division which, between FY14 and FY16 contributed on an average 69.9% of revenue. For this, the group has two long term strategies: 1) to grow recurring income via the implementation of a customer relationship management software within 18 to 24 months after listing, and 2) to widen its target markets from 3 to 6 segments. Recurring income relates to the provision of service, maintenance and supply of spare parts and over FY14 to FY16 grew at a CAGR of 24.0% to RM33.7mn. With a software in place to monitor customer s equipment status, service calls can be initiated in a timelier manner. Meanwhile, the 3 new segments the group intends to enter are higher education institutions, petrochemical companies and pharmaceutical companies. This would be supplemented by RM8.3mn of the group s IPO proceeds (under CAPEX) which have been earmarked to acquire 53 units of demonstration equipment for marketing to customers. Page 5 of 11

6 Key Risks Foreign Exchange Fluctuations The group is exposed to foreign exchange fluctuations given that it does not hedge its revenue and purchases which are mainly transacted in foreign currency (USD & JPY). During FPE September 2017, the proportion of revenue and purchases transacted in foreign currency was respectively at 63.5% (57.7% USD; 5.8% JPY) and 81.7% (62.2% USD;19.5% JPY). To mitigate this risk, the group strives to coordinate foreign currency revenue and purchases to be in the same currency. Based on our sensitivity analysis, every 1.0% increase/decrease in the USD/MYR or JPY/MYR rate decreases/increases the group s earnings by 1.0%. Technological Advancements Given evolving and rapid technological advancements, it is imperative for the group s vendors to design and develop new products to keep pace and meet changing demands of end-markets (i.e. consumer electronics, automotive and semiconductor industry). Failure to do so would impact the group s financials. In efforts to mitigate this risk, the group actively participates and engage with customers to keep abreast of the latest technological advancements and market expectations. Financials Over the past three years, the group s revenue and earnings grew at a CAGR of 14.1% and 34.5%. Growth was driven by the distribution division on the back of existing and new customers expansion and upgrading requirements. Furthermore, in tandem with the increase in the number of test and measurement equipment and materials and engineering solutions sold, the group secured further contracts for the provision of services, maintenance and supply of spare parts. More recently, for FYE September 2017, the group enjoyed revenue and earnings growth of 47.8% YoY (+RM45.1mn) and 85.2% YoY (+RM5.5mn). The robust growth was driven by both the distribution and manufacturing division as well as the consolidation of subsidiaries acquired QES (Singapore), QES (Thailand) and QES (Philippines) which contributed additional revenue of RM8.3mn. PAT margins expanded by 1.9pp to 9.1% mainly due to the sale of higher margin products. Figure 3: Revenue Breakdown by Divisions Figure 4: Distribution Division s Revenue Breakdown Distribution Manufacturing Product Distribution Services & Supply of Spare Parts 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 12% 7% 7% 6% 11% 88% 93% 93% 94% 89% FY14 FY15 FY16 FPE16 FPE17 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 24% 21% 26% 28% 31% 76% 79% 74% 72% 69% FY14 FY15 FY16 FPE16 FPE17 Page 6 of 11

7 Figure 5: Product Distribution Revenue Breakdown Figure 6: FY16 Revenue Breakdown by Country Equipment Materials & Engineering Solutions 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 34% 31% 32% 28% 31% 66% 69% 68% 72% 69% FY14 FY15 FY16 FPE16 FPE17 The Philippines, 10.1% Singapore, 11.1% Others, 16.8% Vietnam, 14.3% Malaysia, 47.7% Going forward, we expect the group to sustain its growth momentum with FY17/FY18/FY19 earnings growth projected at 62.1%/7.0%/5.0% (3-year CAGR of 22.1%) in tandem with revenue growth of 35.6%/6.9%/6.9%. On hand, the group has an order book of RM45.3 (RM35.3mn from distribution division and RM10.mn from manufacturing division), representing 22.8% of our revenue projections for FY18. In our view, opportunities for the group are present from the sustained growth of its key end-user markets, namely the electrical and electronic, automotive and semiconductor industry. These industries are expected to expand alongside global economic growth, rising disposable income and technological advancements which in turn drive demand for upgrades and/or more sophisticated test and measurement equipment, materials and engineering solutions. CAPEX is estimated to be <5% of the group s revenue and will mainly be expended on the purchase of demonstration units for the distribution division s marketing to customers. As for dividends, there is no dividend policy but we assume a payout ratio of 20% which implies yields of 2.1%/2.3%/2.4% during FY17/FY18/FY19. Meanwhile, for leverage, we expect gearing to decline from 0.4x to 0.2x with the utilisation of RM7.0mn from IPO proceeds to pare down borrowings. Figure 7: Revenue Projection Figure 8: Profit Projection RM mn' 250 RM mn' 20 PAT (LHS) PAT margins (RHS) 10.0% % % 4.0% 2.0% 0 FY14 FY15 FY16 FY17F FY18F FY19F FPE16 FPE17 0 FY14 FY15 FY16 FY17F FY18F FY19F FPE16 FPE17 0.0% Valuation At the IPO price of RM0.19/share, the QES is priced at a trailing PE of 9.1x. We value QES at a fair value of RM0.26/share based on a target PE of 12.0x and CY18 EPS of 2.2sen/share. As a benchmark, peers in the test and measurement market such as Elsoft Research and ViTrox Corporation Bhd respectively are trading at PE multiples of 19.6x and 29.0x. The discount we assign to QES is in consideration of Page 7 of 11

8 it being a small-cap listing on the ACE Market and its relatively lower margins (single-digit versus peers double-digit) due to the bulk of its revenue derived from distribution which fetch thinner margins. Not Rated. Figure 9: FYE 2016 Revenue Comparison Figure 10: FYE 2016 Profit Comparison RM mn' RM mn' PAT (LHS) PAT margin (RHS) 60% 50% 40% 30% 20% 10% 0 QES Elsoft MMS Ventures VisDynamics ViTrox 0 QES Elsoft MMS Ventures VisDynamics ViTrox 0% Table 6: Earnings Summary (RMmn) FYE Dec FY15 FY16 FY17F FY18F FY19F Revenue EBITDA EBITDA margin (%) Depreciation & amortisation (1.8) (1.7) (1.7) (2.5) (3.6) EBIT Net finance costs (1.4) (1.0) (0.8) (0.2) 0.3 PBT Taxes (2.3) (1.9) (3.8) (4.1) (4.3) MI (0.4) (0.7) (0.9) (1.0) (1.0) PAT (-MI) EPS (sen) EPS Growth (%) PE (x) DPS (sen) Dividend yield (%) Table 7: Peers Comparison Price TP Recom. Market Cap. PE (x) Dividend yield (%) ROE (%) Company (RM) (RM) (RM mn') CY17 CY18 CY17 CY18 CY17 CY18 Elsoft Research Bhd HOLD MMS Ventures Bhd Not Rated n/a n/a n/a n/a n/a n/a Visdynamics Holdings Bhd Not Rated 80.9 n/a n/a n/a n/a n/a n/a Vitrox Corp Bhd* Not Rated 3, * Based on consensus data Page 8 of 11

9 Appendix 1: Distribution Division Inspection Equipment Appendix 2: Distribution Division Test Equipment Appendix 3: Distribution Division Measurement Equipment Page 9 of 11

10 Appendix 4: Distribution Division Materials Appendix 5: Distribution Division Engineering Solutions Appendix 6: Manufacturing Division Page 10 of 11

11 (THIS PAGE IS INTENTIONALLY LEFT BLANK) Stock Recommendation Guideline BUY : Total return within the next 12 months exceeds required rate of return by 5%-point. HOLD : Total return within the next 12 months exceeds required rate of return by between 0-5%-point. SELL : Total return is lower than the required rate of return. Not Rated: The company is not under coverage. The report is for information only. Total Return is defined as expected share price appreciation plus gross dividend over the next 12 months. Gross dividend is excluded from total return if dividend discount model valuation is used to avoid double counting. Required Rate of Return of 7% is defined as the yield for one-year Malaysian government treasury plus assumed equity risk premium. Disclaimer The information in this report has been obtained from sources believed to be reliable. Its accuracy and/ or completeness is not guaranteed and opinions are subject to change without notice. This report is for information only and not to be construed as a solicitation for contracts. We accept no liability for any direct or indirect loss arising from the use of this document. We, our associates, directors, employees may have an interest in the securities and/or companies mentioned herein. As of Tuesday, February 20, 2018, the analyst, Wilson Loo, who prepared this report, has interest in the following securities covered in this report: (a) nil Kaladher Govindan Head of Research TA SECURITIES HOLDINGS BERHAD (14948-M) A Participating Organisation of Bursa Malaysia Securities Berhad Menara TA One 22 Jalan P. Ramlee Kuala Lumpur Malaysia Tel: Fax: Page 11 of 11